To me, Berkshire Hathaway's (BRK.A, Financial) (BRK.B, Financial) energy business, Berkshire Hathaway Energy (BHE) does not seem like a "traditional" Warren Buffett (Trades, Portfolio) business.
Historically, the Oracle of Omaha has tended to favor high return on capital operations like See's Candy. The utility and railroad businesses do not meet these criteria. In fact, you could make a good argument that these operations are the exact opposite. They require a lot of capital to run.
When they are in operation, owners have to invest a lot of cash to keep them operating effectively and meet regulated investment requirements. For this reason, utilities have historically been relatively poor investments.
Nonetheless, Buffett appears to like these operations because they are predictable cash producers. The key phrase here is "predictable." While utility companies do consume a lot of capital, they usually produce a stable return on that capital. This is unlike other capital intensive industries such as mining, which are highly cyclical.
At Berkshire's 2009 meeting of shareholders, Buffett explained this concept in a bit more detail:
"The utility earnings, pretty much, come about through a return on equity capital allowed by the jurisdictions in which you operate. So, for example, if something like pension costs or something of the sort, you get surprises on, you do get to earn that back over time. But you don't get any bonanzas, either.
So I would say the capital-intensive businesses that scare me more are the ones outside of the utility field, where you just pump in more money without knowing that you're going, in a general way, to get, more or less — within a range, anyway — a guaranteed return.
So I do not have — there's no way we get rich on our utility investments. But there's no way we get poor, either. And we get decent rates of return on the equity that we leave in it."
These businesses were perfectly adequate places to invest capital, but as Buffett went on to explain, high return companies with a wide moat would always be the better option:
"On balance, if you can find a good business that's not capital intensive, you're going to be better off than in a capital-intensive business over time. I mean, the world, they're hard to find. But the best businesses are the ones that don't require much capital and, nevertheless, make good money."
There are a handful of points we can take away from these comments. For a start, high capital intensity businesses are not always disasters. Some can produce good returns, although operations with low capital intensity may produce better returns over the long run.
Second, buying high capital intensity businesses with predictable earnings streams can be an excellent way to stay wealthy. It's the ones without the unpredictable earnings streams that investors should stay away from. Utility companies are not the only businesses that fall into this bracket. Railroads are another great example (barring black swan events like the current economic crisis).
Third, reinvestment is vital. Many utility businesses struggle to provide shareholder value as they pay out the majority of their income to investors with dividends. BHE retains all of its capital. This has helped the company fund its own growth over the years and build equity for Berkshire and its investors.
There are not many other utility companies that follow this path and deploy capital efficiently. The ones that don't should be avoided. They may only destroy shareholder equity over the long run.
Disclosure: The author owns shares in Berkshire Hathaway.
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